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Aarati Krishnan

Set for take off

ONLY investors with an appetite for risk should consider taking up the Jet Airways offer. We believe that the stock is reasonably valued at the lower end of the price band. At the upper end, returns over the medium-to-long-term could be modest. The offer opens on February 18 and closes on February 24.

The airline business is risky, with capital-intensive operations, volatile earnings and the possibility of losses, if traffic slumps due to external shocks or an economic downturn.

The ambitious pricing for this offer, which values the Jet Airways stock at between 22 and 27 times its 2004-05 earnings at the two ends of the price band, also pegs up risk. The price demands a premium over other airline stocks with profitable operations in Asia.

Nevertheless, Jet Airways is best placed to capitalise on the revival in domestic air travel, which now appears to be taking off. With a strong focus on business travel and a reputation for good service and on-time performance, Jet Airways is less vulnerable to competition from low-cost carriers than the others operating in the Indian airspace.

The cost differential between the legacy and no-frills airlines is lower in India than in the developed world. Therefore, while low-cost carriers may be better placed to tap the explosive growth in traffic from first-time air travellers,

Jet Airways is likely to retain its dominant share in premium tourist and business travel segments. With its strong presence in the metro routes, the airline could see a steady improvement in revenues, as business travel picks up on the back of buoyant economic activity.

Other start-ups in the no-frills airline business, which plan to enter the fray over the next few months, will require at least a two/three-year window to stabilise their operations and may not pose a near-term threat to Jet's operations.

The Jet Airways stock could also command a premium valuation for now, due to its market dominance with a 42 per cent market share, and attract investors as the only listed airline with profitable operations.

Experience with high growth sectors such as telecom, retailing and hotels shows that this premium could be significant.

Focus on trunk routes

Jet Airways services 42 domestic destinations with a fleet of 42 aircraft. The company's focus is on serving trunk routes among five major hubs (Mumbai, Delhi, Kolkata, Chennai, Bangalore), with over half of its flights originating in Mumbai. It differentiates itself from the competition with high frequency of flights at convenient times, premium in-flight service and consistent on-time performance.

The company manages a young fleet by international standards with an average age of 4.5 years. This coupled with a homogenous fleet structure (Jet uses only Boeing and ATR aircraft), which reduces inventory and maintenance costs, helps it maintain a competitive cost structure.

The company's access to a significant number of parking bays and prime-time landing slots at Mumbai, Delhi and other airports, gives it considerable flexibility in scheduling flights and reducing turnaround times.

New entrants to the business may find it difficult to secure an equal number of parking berths at these busy airports over the next couple of years, until the modernisation projects are implemented. Even after they are, established airlines such as Jet would get additional slots in the new facilities.

Mr Naresh Goyal, Chairman

Buoyancy in traffic

With a high fixed cost component to its operations, Jet's profitability is sensitive to changes in the load factor on its planes. Jet reported net losses in 2001-02 and 2002-03, when its load factor dropped to 61-62 per cent on the back of a dull economic and industrial scene and poor tourist arrivals.

The company turned around in 2003-04 and profits rebounded strongly to Rs 123 crore in the first half of 2004-05, as the load factor climbed to 67 per cent with robust growth in passenger traffic. In this context, the strong domestic passenger growth augurs well for the company.

The first nine months of 2004-05 saw domestic passenger traffic surge by an unprecedented 26 per cent, after notching up an annual rate of 9 per cent over the last five years.

Traffic appears to have been stimulated by higher frequency of business travel, buoyant tourist arrivals and lower fares, which have made air travel affordable for a larger proportion of the population.

A significant part of the market expansion arising from first-time travellers may have accrued to the low-cost carrier.

However, with a 17 per cent growth in passengers carried in the first nine months, it is clear that Jet has captured a reasonable share of the traffic growth, despite the tough competitive environment.

Increased competition from lower fares and promotional offers has kept Jet's average revenues almost flat over the past year. Fuel costs have also escalated sharply. Yet, Jet's operating profit margins rose from 23.5 per cent in the first half of 2002-03 to 25.9 per cent in the first half of 2003-04 due to improved load factor. Intensifying competition will continue to make fare increases difficult for Jet Airways.

However, there could be scope for profit expansion linked to robust growth in passenger traffic, which will drive revenue growth. Jet's plans to add seven new Boeing 737-800 aircraft in 2005 on lease could also give it the first-mover advantage in a growing passenger traffic milieu.

Recent regulatory approvals that allow Jet to ply international routes such as Singapore, London, Malaysiaand the US could help it improve the overall load factor on its operations, though margins on these segments could be lower than on domestic operations.

Balance-sheet strength

With part of the proceeds from this offer going to retire high-cost debt, Jet's debt-equity ratio is expected to come down from 5.4:1 now to about 1:1 after the offer. This is a comfortable gearing for an airline and would place Jet in a good position to contract further borrowings or secure favourable lease terms for its fleet acquisition plans. Airlines in India could also benefit from the favourable regulatory environment for the aviation industry.

Risks

A significant loss of market share to competitors, an unexpected slump in passenger traffic and pricing pressures are the key risks that could seriously undermine profitability, post-listing.

With a slew of promotional offers from Indian Airlines and Air Sahara and the advent of no-frills competitors, Jet has limited leeway to hike airfares.

Profit growth is thus predicated largely on its ability to increase passenger traffic from premium business travellers and tourists. If this does not happen, Jet's profitability could shrink.

Any slump in passenger traffic would also be particularly damaging at a time when aircraft rentals are set to balloon on the back of Jet's fleet expansion plans.

The recurring questions about the ownership of Jet Airways and dealings with group companies also raise risks associated with this stock. Jetair Private Ltd, a company controlled by the promoter, is the General Sales Agent for Jet Airways and earns a commission on passenger and cargo sales routed to the company.

The Jet Airways trademark is owned by another group company. There is a proposal to transfer this brand to Jet Airways in the next six months at a consideration not exceeding $7.5 million (equivalent of Rs 33 crore).

Background: Jet Airways is offering 1.72-crore shares through this book-built public offer, of which 1.42-crore shares represent a fresh offer and 0.3-crore shares are an offer-for-sale by Tail Winds Ltd, the promoter company. The price band is Rs 950-1,125.

The promoters will hold 80 per cent of the post-offer equity, which will stand at Rs 86.3 crore. Of the offer proceeds of between Rs 1,353 crore and Rs 1,603 crore (depending on the pricing), about Rs 792 crore will be used to repay debt and retire cumulative preference shares and Rs 460 crore will be used to fund capital expenditure on a maintenance hangar, ground handling equipment and simulators.

For the nine months ended December 2004, the company made a net profit of Rs 259 crore on revenues of Rs 3,197 crore. This translates into per share earnings of about Rs 42 on an annualised basis on the post-offer equity base.

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